Investors continue to fear risk of Italy’s hung parliament

By: Chiara Albanese | 11 Feb 2013

With less than two weeks to go to Italy’s elections day, international investors continue to weight the political risk which is likely to affect the market before and after the elections scheduled on February 24 and 25.

The current opinion polls remain consistent with a PD-Monti victory in both Chambers, however the margin is thin and according to Bill Hubard, chief economist at Markets.com, the risk of a hung parliament has increased significantly.

A hung Senate would affect growth prospects in three ways, the economist added. Political uncertainty will weigh on investors’ sentiment, raising the cost of borrowing for the State and the private sector. It would weigh on domestic confidence, pushing the private sector further into precautionary savings.

It would reduce the prospects for structural reforms, undermining long term growth improvements. In a meagre growth outlook for the coming decade, which is where Italy is today, the debt to GDP ratio is unlikely to fall in the coming 2 years. A falling trajectory thereafter is viable, but requires a further increase of the primary surplus and looooow interest rates.

“We believe that what is at stake is the amount and timing of structural reforms to be implemented in 2013 and 2014. We see it as highly unlikely that any of the structural reforms introduced in 2012, will be undone or that fiscal policy will be loosened aggressively, even if former PM Silvio Berlusconi’s party gains further blocking the Senate,” he said.

The Senate may end up hung if either Berlusconi gains popularity, PD loses further support or Monti loses approval rating. If the centre-left coalition fails to secure at least 158 seats together with Monti then either another grand coalition would surface or elections may be called again in a matter of months.

“In our view the difference between a centre-centre-left victory and hung parliament is on their impact on market confidence and growth pro-spects going forward, it is not about whether previous reforms will be undone or whether fiscal prudence will be abandoned,” Hubard added.

Whoever wins the elections will have to keep fiscal policy consistent with the budget principle that all tax changes must be budget neutral. Plus, with a high debt burden, still heavily financed by non-resident investors, scope for arbitrary fiscal easing is inexistent in Hubard’s view.

“In our view, the worst case scenario is that of early elections months after the February polls as this would imply that no co-operation between political parties is viable and there will be several months of uncertainty on whether voters’ preferences would shift, if at all,” he said.